Is There a Bin Laden Trade?

by Michael Shulman | May 5, 2011 9:25 am

Is There a Bin Laden Trade?

Osama bin Laden is dead. Is there a trade?

A trade around bin Laden is a trade around geopolitical risk and that comes in two forms. The first involves major events that create structural changes in economies, for instance the September 11 attacks that sent the U.S. to war in Afghanistan.

The second is event risk that fades rapidly — that would be the tsunami in Japan or the revolution in Egypt — a non-oil producing country.

The death of bin Laden has reduced the possibility of a major event; say a weapon of mass destruction attack. For this reason the price of oil is falling. With the falling dollar, oil should be rising, so this impact is not over. And this has created an opportunity for the smart and patient trader.

Forgetting major geopolitical risks for a moment, remember that oil usage is increasing due to rapid growth in emerging markets while demand is stalled in developed markets. This forms the basis of a great trade – a long-term long position in oil that could occasionally move upward, big time, due to a geopolitical event.

This offers us two types of options trading[1] opportunities – a buy-write or the straight up purchase of calls.

Option Trade 1 – Buy-Write on XLE or USO

First, the buy-write trade. Buy an energy ETF such as the Energy Select Sector SPDR (NYSE: XLE[2]) that represents energy producers or the US Oil Fund (NYSE: USO[3]), an ETF that represents the price of oil. Options on these ETFs are liquid and easy to trade.

These ETFs are sliding so take your time; wait until you see a bottom or average in. Once you are in, turn around and write covered calls that are out-of-the-money and at least two months out. Take the premium you are paid for selling the calls and put it in the bank. If the price of oil and energy continue to decline, you have lowered the basis of your investment, and you can buy back the calls at a cheaper price. You then sell them again at another two months out. Repeat this process while this is profitable.

This trading can also be done on a more immediate basis with the Weekly options that trade on both the USO and the XLE.

If the price of oil increases, as it will over time, the value of the underlying ETF increases and you can still write covered calls, the only risk that of foregone profit. That is, if the ETF goes up in value it will be called away from you and you will have to give up your holding in the ETF as it rises.

Option Trade 2 – Straight Call Purchase of XLE or USO

Second, if you are more of a gambler than I am, buy the calls outright. But you need to choose a month that expires late in the year or a LEAP. They will spike if the price of oil spikes but the later date gives the fundamentals a chance to work. There are LEAPs available for both USO and XLE.